Question

During 2018, Barden Building Company constructed various assets at a total cost of $10,500,000. The weighted average accumulated expenditures (WAAE) on assets qualifying for capitalization of interest during 2018 were $7,000,000. The company had the following debt outstanding at December 31, 2018: • 10%, 5-year note to finance construction of various assets, dated January 1, 2017, with interest payable annually on January 1 $4,500,000 • 12%, twelve-year bonds issued at par on December 31, 2009, with interest payable annually on December 31 6,000,000 • 9%, 4-year note payable, dated January 1, 2016, with interest payable annually on January 1 3,500,000 Instructions Compute the amounts of each of the following (show computations). 1. Actual interest 2. Average Interest Rate 3. Avoidable interest 4. Interest to be capitalized during 2018 5. Interest expense reported 2018

Answer 1

1	Actual interest
						$
	Interest on 10% note		(4500000*10%)			450000
	Interest on 12% bond		(6000000*12%)			720000
	Interest on 9% note		(3500000*9%)			315000
	Total actual interest					1485000
2	10%,5 year note is used to finance the construction of various assets.
	Hence, it is a specific borrowing
	12% bonds and 9% bonds are for general purpose.
	Hence, they are general borrowings
	Average interest rate is computed on general borrowings
	Average interest rate=Total interest expense/Total principal
	General debt	Principal	Interest expense
	12% bond	6000000	720000
			(6000000*12%)
	9% note	3500000	315000
			(3500000*9%)
	Total	9500000	1035000
	Average interest rate=1035000/9500000=0.108947=10.89%
3	Avoidable interest=Interest on specific borrowing+[Average rate*(Weighted average accumulated expenditure-Specific borrowing)]
	Avoidable interest=450000+[10.89%*(7000000-6000000)]=450000+108900=$ 558900
4	Interest to be capitalized:
	Since actual interest ($1035000) greater than avoidable interest (558900) capitalize avoidable interest
	Hence,Interest to be capitalized=Avoidable interest=$ 558900
5	Interest expense=Actual interest-Avoidable interest=1035000-558900=$ 476100